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Ring-fencing in financial networks

Author

Listed:
  • Bardoscia, Marco

    (Bank of England)

  • Ka-Kay Pang, Raymond

    (London School of Economics and Political Sciences)

Abstract
Ring-fencing is a reform of the UK banking system that requires large banks to separate their retail services from other activities of the group, such as investment banking. We consider a network of bilateral exposures between banks in which financial contagion can spread because banks incorporate the creditworthiness of their counterparties into the valuation of their assets. Ring-fencing acts as an exogenous shock that impacts the creditworthiness of banks through leverage, depending on how assets are allocated between ring-fenced and non-ring-fenced entities. We find conditions on this allocation that leads to safer ring-fenced entities and less safe non-ring-fenced entities when compared with their groups prior to the implementation of ring-fencing. We also show that ring-fencing can make both the equity of individual banking groups and the aggregate equity of the banking system decrease. When this happens, ring-fenced entities are safer than their groups prior to ring-fencing.

Suggested Citation

  • Bardoscia, Marco & Ka-Kay Pang, Raymond, 2023. "Ring-fencing in financial networks," Bank of England working papers 1046, Bank of England.
    • Handle: RePEc:boe:boeewp:1046
    as

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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2023/ring-fencing-in-financial-networks.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Ring-fencing; financial networks; systemic risk;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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